Investing in Clients/Stock for FeesHome/Table of Contents
John S. Dzienkowski & Robert J. Peroni, The Decline in Lawyer Independence: Lawyer Equity Investments in Clients
, 81 Tex. L. Rev. 405 (Dec. 2002). Putting aside the authors' somewhat negative view of lawyers investing in clients, this is a very comprehensive (143-page) and useful treatment of the subject. It covers the ways lawyers and law firms invest in clients, the ethics rules and ethics opinions, the interface with securities laws, and the problems for clients and lawyers sometimes introduced by such investments. Virtually all the material that follows this paragraph on this page is considered and updated in this article.
Lawyers Doing Business with their Clients: Identifying and Avoiding Legal and Ethical Dangers, A Report of the Task Force on the Independent Lawyer, Section of Litigation Section, American Bar Association (undated, but released in January 2002). This is a 181 page document exhaustively treating the entire subject of doing business with clients. The Task Force does not propose the prohibition of the practice, but rather makes suggestions for doing it safely and ethically. One of the many helpful appendices is one containing ALAS' suggested policies and forms for law firms wanting to regulate this practice. This wonderful compendium stands in sharp contrast with the Litigation Section's heavy-handed and ill conceived attempt ten years ago to prohibit law-related businesses. This new report describes that effort, among many other things.
On July 7, 2000, the ABA Standing Committee on Ethics and Professional Responsibility issued its Formal Opinion 00-418, "Acquiring Ownership in a Client in Connection with Performing Legal Services." It contains no surprises. It says that such arrangements are not per se unethical. It says that lawyers taking client securities must comply with Model Rule 1.8(a). That means the arrangement must be in writing, the client be afforded a reasonable opportunity to consult with other counsel, the client's consent to the arrangement be in writing, and the terms be "fair and reasonable" to the client. The opinion discusses the interplay of the "fair and reasonable" requirement of Rule 1.8(a) and the requirement of Rule 1.5(a) that fees be "reasonable." It also deals with the need to disclose possible conflicts to the client and the role of Model Rule 1.7(b).
N.Y. City Bar Op. 2000-3 (2000), which was rendered soon after ABA Op. 00-418, basically tracks the ABA Op. 00-418, described above. In brief summary, it is slightly more lenient than ABA Op. 00-418. It says that the lawyer does not have to comply with N.Y. DR 5-104(A) (N.Y.'s version of Model Rule 1.8(a)), unless the client is relying upon the advice of the lawyer with respect to the fee transaction itself. Thus, the Committee concludes, there may be instances in which a lawyer takes stock in lieu of fees where it would be appropriate to treat the arrangement as any other fee arrangement. The sophistication of the client and complexity of the transaction will obviously play a role in whether this is the case. In other respects, N.Y. City Bar Op. 2000-3 (2000) is comparable to ABA Op. 00-418.
D.C. Bar Op. 300 (July 25, 2000). It mentions ABA Op. 00-418 and N.Y. City Bar Op. 2000-3, only in a footnote, but states that Op. 300 reaches the same conclusions as those two opinions. Actually, unlike N.Y. City Bar Op. 2000-3, Op. 300 does not discuss situations in which such an arrangement might not be subject to Rule 1.8(a) or its New York counterpart, DR 5-104. Restatement
. See §§ 76 & 126. Rule 1.8(a)
. Failure to comply with Rule 1.8(a) can have harsh consequences. In Passante v. McWilliams
, 62 Cal. Rptr. 2d 298 (Cal. App. 1997), failure to comply with California’s version of Rule 1.8(a), in part, cost the lawyer his ability to collect $32 million worth of stock from a client. Sands v. Menard
, Nos. 2012AP2377 & 2015AP870 (Wis. Sept. 20, 2016) was similar to Passante
. In Santiago v. Evans, 2012 U.S. Dist. LEXIS 167983 (M.D. Fla. Nov. 27, 2012), the court found the sale of a vessel void due to the purchaser's (lawyer) failure to comply with the rule.
In Gurvey v. Legend Films, Inc., 2012 U.S. Dist. LEXIS 131547 (S.D. Cal. Sept. 14, 2012) the court did not allow lawyer to take an interest in the client for failure to comply with Rule 1.8(a).
In BGI Associates, LLC v. Wilson
, 7 Cal. Rptr. 3d 140 (Cal. App. 2003), a lawyer's evident failure to comply with the California rule caused him to lose breach of contract case. In Fair v. Bakhtiari,
2011 Cal. App. LEXIS 634 (Cal. App. May 24, 2011) the court held that a lawyer’s failure to advise the client in writing of the right to seek other counsel would be grounds for denial of quantum meruit. Likewise, in DiLuglio v. Providence Auto Body, Inc
., 755 A.2d 757 (R.I. 2000), the court held that a lawyer’s failure to comply with Rule 1.8(a) in contracting with a client could entitle the client to rescind the contract. (The court denied rescission in DiLuglio
, because the client waited six years to raise the issue.) Page v. ADS Invs., LLC
, 2014 R.I. Super. LEXIS 106 (R.I. Super. Aug. 5, 2014) (following DiLuglio
, court "voided" lawyer's ownership interest for violating rule); LK Operating, LLC v. Collection Grp., LLC
, 2014 Wash. LEXIS 573 (Wash. July 31, 2014) (rescission appropriate); Rhodes v. Buechel
, 685 N.Y.S.2d 65 (N.Y. App. 1999) (recission appropriate where disclosure not adequate). In In re Nelson
, 681 N.W.2d 352 (Minn. 2004), the lawyer was disbarred. In In re Trewin
, 684 N.W.2d 121 (Wisc. 2004), a lawyer was suspended for five months for lending money to clients but not complying with Rule 1.8. Same result in In re Gebo
, 796 N.Y.S.2d 918 (N.Y. App. 2005). Lawyer leased property from client without complying with New York's version of Rule 1.8(a); client stated a cause of action for breach of fiduciary duty, McMahon v. Eke-Nweke
, 503 F. Supp. 2d 598 (E.D.N.Y. 2007). Florida Bar v. Ticktin
, 2009 Fla. LEXIS 1254 (Fla. May 21, 2009) (lawyer suspended for not complying with Rule 1.8(a) when becoming officer of, and investor in, client). In In re Liebowitz
, 2010 N.Y. App. Div. LEXIS 6811 (N.Y. App. Div. Sept. 28, 2010), a lawyer was publicly reprimanded for borrowing money from union client without complying with New York’s version of Rule 1.8(a). In People v. Bates
, 2011 Colo. Discipl. LEXIS 55 (Col. Discipl. Justice Sept. 15, 2011) lawyer was disbarred for violating Rule 1.8(a) in a real estate investment context. In In re Spencer, 2014 Ore. LEXIS 483 (Ore. June 26, 2014) lawyer/real estate broker disciplined. Stillwagon v. Innsbrook Golf & Marina, LLC
, 2014 U.S. Dist. LEXIS 120938 (E.D.N.C. Aug. 29, 2014); Law Offices of Peter H. Priest, PLLC v. Coch,
2014 NCBC LEXIS 55 (N.C. Super. Ct. Nov. 5, 2014) (contract prepared by lawyer unenforceable). 1.8(a); Remarkably Similar to
Passante, but Court Did not Discuss Rule or Passante. Goldston v. Bandwidth Tech. Corp
., 2008 WL 2445496 (N.Y. App. June 19, 2008).
In Rubin v. Murray
, 2011 Mass. App. LEXIS 365 (Mass. App. March 16, 2011), the court approved a 1975 stock-for-fees arrangement and discussed the applicability of DR5-104(A) and Rule 1.8(a). The lawyer had advised the other parties to talk to other counsel, and the other parties were sophisticated. 1.8(a); Referring Client to Wife's Real Estate Firm
. N.J. Op. 696 (5/16/05). The Committee said that where a lawyer for an executor lists estate property with the real estate broker employing his wife, the lawyer must comply with New Jersey’s version of Model Rule 1.8(a). 1.8(a); Lawyer for Estate and Realtor for Estate Sale Should Have Complied with Rule. In re Estate of Brown
, 930 A.2d 249 (D.C. App. 2007). 1.8(a); In re Fisher,
2012 U.S. Dist. LEXIS 8293 (S.D.N.Y. Jan. 24,
2012). In this disciplinary proceeding and in this opinion Judge
Rakoff, acting as Chair of the Committee on Grievances of the S.D.N.Y.,
immediately suspended Lawyer, in part, for borrowing money from a client
but failing to comply with Rule 1.8(a) or its predecessor, DR5-104(A).
The term of the suspension will be determined at a later date. Smith-Canfield v. Spencer
, 2011 Bankr. LEXIS 1822 (D. Ore. May 17, 2011). Defendant was a lawyer and real estate broker. While giving Plaintiff bankruptcy advice, Defendant also assisted Plaintiff in buying a home. There were problems with the property, and Plaintiff sued Defendant for legal malpractice and real estate broker malpractice. Defendant tried to defend, in part, by claiming he was not acting as a lawyer in the real estate transaction. The court rejected that claim saying:
Defendant cannot simply remove his attorney hat and put on his broker hat when he and Plaintiff went house-hunting.
Among other things, the court held that Defendant had failed to comply with Rule 1.8(a). 1.8(a); In Donald J. Weiss & Associates, P.C. v. Tulloch
, 2008 Pa. Super. LEXIS 3511 (Pa. App. Oct. 30, 2008), the court said that violation of “Rule 1.8” (presumably 1.8(a)) did not invalidate a note the lawyer had taken from the client to secure fees. The court did rule against the lawyer as a matter of contract law. Contract Violating Rule 1.8(a) not Enforceable. Calvert v. Mayberry
, 2016 WL 1593821 (Col. App. April 21, 2016).
Lawyer, pursuant to an oral agreement, lent a feeble client substantial
sums of money without complying with Rule 1.8(a). In this case Lawyer
sued to collect the loans. The trial court found for the client. In this
opinion the appellate court affirmed. The court adopted the rule that a
lawyer may not enforce a contract that violated Rule 1.8(a), because
that rule is an expression of “public policy.” Gorshek v. Trewin
, 2010 Wisc. LEXIS 46 (Wis. June 24, 2010). Lawyer purchased his clients' farm. The clients sued for breach of fiduciary duty. The trial court found for the clients and ordered the purchase rescinded. The appellate court affirmed, and in this opinion the supreme court affirmed. The trial court had also ordered punitive damages. The supreme court held (with one dissent) that because there were no compensatory damages, an award of punitive damages would be inappropriate. The overall outcome of this case was heavily dependent on the factual findings of the trial court. This opinion contained no mention of Rule 1.8(a). Purchasing Client’s Property. Houston v. Ludwick
, 2010 Tex. App. LEXIS 8415 (Tex. App. Oct. 21, 2010). In this opinion the court upheld a $142,000 breach-of-fiduciary-duty jury verdict against a lawyer who had received four condominium units from the plaintiff/client in payment of fees. Among other things, the jury held that the client received considerably less than what the units were worth. The court did not mention Texas' version of Model Rule 1.8(a). Rule 1.8(a). Asymmetrx Med., Inc. v. McKeon, 2012
U.S. Dist. LEXIS 38218 (D. Mass. March 2, 2012). One of the issues in
this case is Lawyer's right to an equity interest in Company. Opponents
of Lawyer claim that Lawyer should not have an equity interest in part
because Lawyer violated "Rule 1.8" (presumably Rule 1.8(a)). In this
opinion the magistrate judge, relying in part upon the Scope statement
in the Massachusetts Rules, held that the violation would not deprive
Lawyer of her equity interest. Fee Unreasonable; 1.8(a) Discussed. Holmes v. Loveless
, 94 P.3d 338 (Wash. App. 2004). A law firm represented a real estate joint venture in connection with the development of a shopping center. The fee agreement provided for a discounted billing rate for 2 1/2 years in exchange for an agreement to pay the law firm 5% of the revenues of the shopping center. After the shopping center became successful, the joint venture balked at paying the 5%. In litigation over the fee, this court held that the fee, while possibly reasonable when it was agreed to, had become unreasonable and was no longer enforceable. Lawyer Released in Settlement Document and Effect of Rule 1.8(a). Berner Cheese Corp. v. Krug
, 2008 Wisc. LEXIS 347 (Wis. July 15, 2008). 1.8(a); Lawyer Disbarred. Florida Bar v. Doherty, 2012 Fla. App. LEXIS 623 (Fla. App. March 29, 2012)
. 1.8(a); Violation Triggers Exception in Malpractice Policy. Minnesota Lawyers Mut. Ins. Co. v. Antonelli, Terry, Stout & Kraus, 2012 U.S. App. LEXIS 6504 (4th Cir. March 29, 2012).
Same result in Taylor v. The Bar Plan Mut. Ins. Co.
, 2015 WL 1094848 (Mo. March 10, 2015). Violation of 1.8(a) as Grounds for Rescission of Contract. LK Operating, LLC v. Collection Group, LLC,
2012 Wash. App. LEXIS 1435 (Wash. App. June 19, 2012)
. Violation of 1.8(a) as Defense to a Civil Case Brought by Lawyer. Law Offices of Peter H. Priest, PLLC v. Coch
, No. COA15-254 (N.C. App. Nov. 17, 2015). 1.8(a) Finding of Preference in Bankruptcy Proceeding
. In re Hadley
, 2015 WL 7455630 (N.D. Ohio Nov. 23, 2015). Chapter 7
bankruptcy. Debtor had transferred two classic cars to Lawyer three
days before filing the bankruptcy. In this proceeding Trustee seeks to
avoid the transfers as preferences. In this opinion granting Trustee
relief, the court said that Lawyer’s failure to comply with Rule 1.8(a)
(no written disclosure, consent, etc.), while not raised by Trustee, was
a factor, among several, influencing the his ruling. 1.8(a; Lawyer as Real Estate Agent
. Conn. Informal Op. 15-03 (Feb. 2015) This opinion discusses the extent to which a lawyer may act both as lawyer and as a real estate agent in the same transaction. Sometimes yes and sometimes no. Rule 1.8(a) plays an important role. 1.8(a); Enforceability of Fee Agreement
. Institutional Labor Advisors, LLC v. Allied Resources, Inc., Civil Action No. 4:12-CV-00044-JHM (W.D. Ky. Aug. 25, 2014). Lengthy discussion of Rule 1.8(a) and its application to a fee agreement. Also a discussion of the admissibility of the testimony of ethics experts. "Client" within 1.8(a). Rafel Law Grp. PLLC v. Defoor,
2013 Wash. App. LEXIS 1919 (Wash. App. Aug. 19, 2013). Law Firm sued
for fees. One of Client's defenses was that a security agreement and
promissory note negotiated between Law Firm and Client at the inception
of the representation violated Washington Rule 1.8(a) (same as MR
1.8(a)). The trial court rejected that argument. In this opinion the
appellate court agreed. The court held, in effect, that at inception of
the representation, when fee documents are created, the person agreeing
to them is not yet a "client" as that term is used in the rule. 1.8(a) Applied to Agreement between Law Firm and Non-Client. SAS Inst., Inc. v. Akin Gump Strauss Hauer & Feld, LLP, No. 5:10-CV-101-H (E.D.N.C. Feb. 6, 2015).
1.8(a); Cancelling Note and Lien. In re Pace
, 2015 WL 6728007 (W.D.N.C. Nov. 2, 2015). Lawyer
represented Debtor in this Chapter 7 proceeding. Prior to filing the
case, and because of Debtor’s financial problems, Lawyer took a note and
security interest to secure his fees. Because Lawyer did not comply
with the requirements of N.C. Rule 1.8(a), the court, in this opinion,
ordered Lawyer to cancel the note, release the lien, and terminate the
financing statement. Ontario's Version of Rule 1.8(a)
. Ontario's Rule 2.06(2.1) is similar to MR 1.8(a), including the requirement that the lawyer recommend that the client seek other counsel. However, in Hillsburg Stables Inc. v. Gardiner Roberts LLP
, 2012 ONCA 95 (CanLII) (Ct. App. Ont. Feb. 13, 2012), the court held that the failure to make the recommendation in connection with an interest to secure fees was not fatal to the interest where the client was sophisticated, not disadvantaged, and the interest was fair. 1.8(a)
. In Chism v. Tri-State Constr., Inc
., 2016 WL 2643355 (Wash. App. May 9, 2016), the court held that Rule 1.8(a) was not implicated when an in-house lawyer negotiates a bonus agreement with his employer. Patent Practice
. In a case related to Rhodes v. Buechel
, 685 N.Y.S.2d 65 (N.Y. App. 1999) (cited above), the court addressed a federal regulation allowing lawyers to take an interest in a patent in lieu of a fee, 37 CFR 10.64(a)(3), Buechel v. Bain
, 713 N.Y.S.2d 332 (N.Y. App. 2000). The court held that the regulation did not excuse lawyers from the disclosure requirements of DR 5-104(A). This was affirmed by the New York Court of Appeals, Buechel v. Bain
, 766 N.E.2d 914 (N.Y. 2001). 37 CFR 10.1 provides that PTO regulations do not preempt the right of states to regulate the practice of law. L.A. County Bar Op. 507 (2001) says that a lawyer may contract with a client for a contingent fee in connection with a new patent prosecution. It further says that 5% of net profits from the sale of the invention was not unconscionable. It said that the lawyer did not have to comply with California Rule 3-300, California's version of Model Rule 1.8(a). Lastly, it said the lawyer did have to comply with section 6147(a) of the California Business & Professions Code, the section regulating contingent fees. The opinion does not mention the PTO ethics rules. D.C. Op. 195 (1988) is the same as the L.A. opinion. William E. Jackson, Contingent Fee Representation in Intellectual Property Cases
, 1 U. Balt. Intel. Prop. L.J. 207 (1993). But see Day v. Meyer
, 2000 U.S. Dist. LEXIS 13470 (S.D.N.Y. 2000) (court refused to grant summary judgment to client even though California lawyer violated California's version of Rule 1.8(a)). Discipline. Gersten v. Statewide Grievance Committee
, 1997 Conn. Super LEXIS 1590 (Conn. Super. 1997) (lawyer disciplined for not complying with Rule 1.8(a)); Attorney Grievance Commission of Maryland v. Hines
, 783 A.2d 656 (Md. 2001) (lawyer had piece of company; misbehaved). Rule 1.8(j): Suing on Note not the Same as Seeking to Foreclose on Mortgage. Ankerman v. Mancuso
, 860 A.2d 244 (Conn. 2004). Rule 1.8(j): Mortgage Taken from Client During Litigation not Valid as Against Public Policy. McLaughlin v. Amirsaleh
, 844 N.E.2d 1105 (Mass. App. 2006). New Jersey and Taking Mortgage to secure Fee. Van Horn v. Van Horn
, 2010 N.J. Super. LEXIS 141 (N.J. App. July 23, 2010). In addition to Rule 1.8(a), New Jersey has a court rule (Rule 5:3-5(b)) that prohibits a lawyer from taking -- during the representation -- a mortgage from a client to secure fees. The plaintiff's lawyer violated that rule, and the trial court disqualified the lawyer. In this opinion the Appellate Division reversed, noting that the rule does not specify a remedy. The court said that it would have been more appropriate for the trial court to order the mortgage discharged. The court also held that there was insufficient material in the record to determine whether the lawyer violated N.J. Rule 1.8(a) or (i). However, the court said the more appropriate remedy for a violation would be invalidation of the mortgage transaction. Mid-Stream Fee Changes
. ABA Op. 11-458 (Aug. 4, 2011). This is an excellent discussion of what rules apply to a lawyer changing a fee arrangement after the representation begins. A change in rates implicates Rule 1.5. Taking an interest in the client's property, such as taking a mortgage to secure fees, implicates Rule 1.8(a). Earlier Cases on Mid-stream Fee Changes. In Valley/50th Ave., L.L.C. v. Stewart
, 153 P.3d 186 (Wash. 2007); In re Haley
, 138 P.3d 1044 (Wash. 2006), In re Richmond
, 904 A.2d 684 (N.H. 2006), In re Hefron
, 771 N.E.2d 1157 (Ind. 2002), Petit-Clair v. Nelson
, 782 A.2d 960 (N.J. Super. 2001), In re Curry, III
, 2009 La. LEXIS 2183 (La. July 1, 2009), and Cotton v. Kronenberg
, 44 P.3d 878 (Wash. App. 2002), the courts held that lawyers who seek to change a fee arrangement after the representation is under way must comply with Model Rule 1.8(a). In Naiman v. New York University Hospitals Center
, 351 F. Supp. 2d 257 (S.D.N.Y. 2005), the court relied, in part, on New York's version of Model Rule 1.8(a) in invalidating a mid-stream change in a contingent fee agreement. Other authorities that deal harshly with mid-stream fee changes (but not citing Rule 1.8(a)) are United States Postal Service v. Haselrig Construction Co.
, 349 F. Supp. 2d 955 (D. Md. 2004); The Florida Bar v. Shankman
, 908 So. 2d 379 (Fla. 2005); McConwell v. FMG of Kansas City, Inc
., 861 P.2d 830 (Kan. App. 1993); Rose v. Failey
, 140 N.E.2d 711 (Ill. 1957); Anderson v. Sconza
, 534 N.E.2d 445 (Ill. App. 1989); Miller v. Solomon
, 199 N.E.2d 660 (Ill. App. 1964); and Jordan v. Ray Schools-Chicago, Inc
., 199 N.E.2d 827 (Ill. App. 1964). See also Chicago Bar Op. 93-1 (1993), which characterizes mid-stream fee changes as "presumptively fraudulent." For a recent contrary view under the Model Code, see Welsh v. Case
, 43 P.3d 445 (Ore. App. 2002). More on Mid-stream Fee Changes; Obtaining Security for Fees. In Valley/50th Ave. LLC v. Morse and Bratt, P.S.C
., 2011 Wash. App. LEXIS 1286 (Wash. App. June 1, 2011), a sequel to In Valley/50th Ave., L.L.C. v. Stewart
, 153 P.3d 186 (Wash. 2007), the court held that the law firm in question had, under Wash Rule 1.8(a), given the client a reasonable opportunity to seek other counsel, and had adequately documented the transaction. ABA Op. 02-427 (2002) discusses this subject in substantial detail. In Re Snyder, 35 S.W.3d 380 (Mo. 2000), was a disciplinary proceeding involving, in part, a lawyer's taking an interest in a client's real estate in lieu of a cash fee to defend a criminal proceeding. The court held that the lawyer should have complied with Missouri's version of Model Rule 1.8(a). That includes advising the client of the terms of the arrangement in writing, giving the client an opportunity to seek the advice of independent counsel, and getting the client's consent in writing. The lawyer failed to comply with Rule 1.8(a) and was suspended for six months. In McRentals, Inc. v. Barber
, 62 S.W.3d 684 (Mo. App. 2001), a lawyer bought a business from a client, and the court held that he substantially complied with Rule 1.8. In Welsh v. Case
, 43 P.3d 445 (Ore. App. 2002), the court upheld a mid-stream mortgage for fees, even though Oregon DR 5-104(A) was not complied with, because the mortgage was not for the clients' benefit, and the clients were sophisticated. In Cotton v. Kronenberg
, 44 P.3d 878 (Wash. App. April 22, 2002), the lawyer had taken the client's real estate and mobile home. The court held that the fee was not fair and reasonable and violated Rule 1.8(a). Arbitration Clause Inserted by Lawyer in Business Agreement not Enforceable by Lawyer. Harris v. Albany Lime & Cement Co
., 2008 Ga. App. LEXIS 470 (Ga. App. April 24, 2008). Lawyer Taking Real Estate in Lieu of a Fee just Prior to Filing Bankruptcy. In re Wentzell
656 N.W.2d 402 (Minn. 2003). Lawyer disciplinary proceeding. Just prior to his client’s filing for bankruptcy, the lawyer had the client convey property to the lawyer in payment of fees the client owed the lawyer. The lawyer was disciplined because his disclosures to the bankruptcy court were inadequate and because of misstatements the lawyer made in connection with the conveyance. [Note: we have been asked by law firms about taking real estate from nearly-insolvent clients in payment of fees. While it certainly may be possible, it should be done extremely carefully, with due regard for the law of preferences, fraudulent conveyances, and the bankruptcy disclosure rules for conflicts of interest
.] 40% Contingent Fee not Ipso Facto a Violation of Rule 1.8(a). Premier Networks, Inc. v. Stadheim & Grear, Ltd
., 2009 Ill. App. LEXIS 1083 (Ill. App. Nov. 10, 2009). Disqualification
. Pennsylvania’s version of Model Rule 1.7(b) was cited in Simms v. Exeter Architectural Products, Inc
., 868 F. Supp. 668 (M.D. Pa. 1994). A lawyer attempted to represent a corporation in which he was a shareholder. The court found that relationship created an inherent conflict of interest and disqualified the lawyer. Likewise, in Landzberg v. 10630 Berea Rd., Inc
., 2002 Ohio App. LEXIS 1085 (Ohio App. 2002), a lawyer/shareholder of a tavern attempted to represent the tavern in a tort case involving an assault at the tavern. The lawyer was also the manager of the tavern on the evening of the occurrence. Because he was almost certainly going to be a witness, the court disqualified his law firm. Class Certification Denied
. In Sipper v. Capital One Bank
, 2002 U.S. Dist. LEXIS 3881 (C.D. Cal. 2002), the court held that because the lawyer who sought to be class counsel was in business with the person who sought to be class representative, the class could not be certified. Tax Court Determinations
. The following cases dealt with the imposition of negligence penalties by the IRS. The defense was that the taxpayer relied on the advice of lawyers in not paying the tax or in paying less than the IRS claimed. In each case the court denied the defense because the lawyer had a business relationship with the taxpayer and, therefore, had a conflict of interest. Addington v. Comm'r
, 205 F.3d 54 (2d Cir. 2000); Pizza Pro Equip. Leasing, Inc
., 2016 WL 6804474 (T.C. Nov. 17, 2016); Kenna Trading, LLC v. Comm'r
, 2014 U.S. Tax Ct. LEXIS 51 (U.S. Tax Ct. Oct. 16, 2014) (discusses conflict but doesn't explain relevance); Zeluck v. Comm'r, 2012 Tax Ct. Memo LEXIS 97 (U.S. Tax Ct. April 3, 2012); Zatz v. Comm'r
, 2011 Tax Ct. Summary LEXIS 87 (U.S. Tax Ct. July 19, 2011); Wiest v. Comm'r
, 2002 Tax Ct. Summary LEXIS 32 (U.S. Tax Ct. 2002); Barlow v. Comm'r
, T.C. Memo 2000-339, 2000 Tax Ct. Memo LEXIS 402 (U.S. Tax Ct. 2000); In re Canada
, 2016 WL 3349165 (N.D. Tex. June 7, 2016) (court found no penalty, but said the taxpayer could nor rely on advice of lawyer). To the same effect are Goldman v. Comm'r
, 39 F.3d 402 (2d Cir. 1994), Weitzman v. Comm'r
, T.C. Memo 2001-215, 2001 Tax Ct. Memo LEXIS 252 (U.S. Tax Ct. 2001), and Robnett v. Comm'r, 2001 Tax Ct. Memo LEXIS 26 (U.S. Tax Ct. 2001), except in those cases, the opinion was that of an accountant who had a business relationship with the taxpayer.
Green Gas Del. Stat. Trust v. Comm’r, 2016 WL 3909765 (T.C. July
14, 2016). Taxpayer was involved in developing and selling gas generated
by landfills. The IRS found that Taxpayer owed taxes and also assessed a
negligence penalty. Taxpayer claimed it had relied on the advice of Law
Firm, but did not proffer a written opinion from Law Firm. Further,
given Law Firm’s unique role in the sale of the gas, Law Firm was
actually a promoter of the sale. Thus, Law Firm had a conflict, and
Taxpayer could not rely on Law Firm’s advice to avoid penalties.
Abusive Tax Shelters. In Klamath Strategic Investment Fund, LLC v. United States, 472 F. Supp. 2d 885 (E.D. Tex. 2007) the court held that to avoid penalties taxpayers could rely on the tax shelter opinion of a law firm that represented not only the taxpayers but also the promoter of the shelters. A similar result was reached in American Boat Co., LLC v. United States of America, 2009 U.S. App. LEXIS 21548 (7th Cir. Oct. 1, 2009). However, in Gustashaw v. Comm'r, 2012 U.S. App. LEXIS 20379 (11th Cir. Sept. 28, 2012); New Phoenix Sunrise Corp. v. Comm'r, 2010 U.S. App. LEXIS 23909 (6th Cir. Nov. 18, 2010), Stobie Creek Invest. LLC v. United States, 2010 U.S. App. LEXIS 11927 (Fed. Cir. June 11, 2010), Salem Fin., Inc. v. United States, 2013 U.S. Claims LEXIS 1372 (U.S. Ct. Cl. Sept. 20, 2013) (BB&T bank, "STARS" transaction; penalty, $113 million), conflict finding aff'd at Salem Fin., Inc. v. United States, 2015 WL 2242421 (Fed. Cir. May 14, 2015); Gerdau Macsteel, Inc. v. Comm'r, 2012 U.S. Tax Ct. LEXIS 30 (U.S. Tax Ct. Aug. 30, 2012); SAS Invest. Partners v. Comm'r, 2012 Tax Ct. Memo LEXIS 160 (U.S. Tax Ct. June 6, 2012); and Kerman v. Comm'r, 2011 Tax Ct. Memo LEXIS 52 (U.S. Tax Ct. March 8, 2011), the courts held that the law firms’ conflicts of interest were so obvious, that the taxpayers could not rely on them to avoid penalties. Likewise in Murfam Farms, LLC v. United States, 2010 U.S. Claims LEXIS 598 (Ct. Cl. Aug. 16, 2010) (citing Stobie Creek). Likewise in Canal Corp. v. Comm'r, 2010 U.S. Tax Ct. LEXIS 25 (U.S. Tax Ct. Aug. 5, 2010) (accounting firm rendering legal opinion had “inherent and obvious” conflict). In Conwill v. Greenberg Traurig, L.L.P., 2010 U.S. Dist. LEXIS 76824 (E.D. La. July 29, 2010), the court held that allegations against a law firm’s fraudulent breach of fiduciary duty triggered Louisiana’s ten-year statute of limitations. There were allegations of undisclosed compensation passing between the law firm in question and the tax shelter promoter. In Behnke v. Ahrens, 2012 Wash. App. LEXIS 1555 (Wash. App. July 2, 2012), a lawyer had to forfeit his fees because of his involvement in a "Son of BOSS" shelter. In Rawls Trading, L.P. v. Comm'r, 2012 Tax Ct. Memo LEXIS 341 (U.S. Tax Ct. Dec. 5, 2012), another "Son of BOSS" case, the court held that the law firm was a "promoter," and could not be relied upon to avoid penalties, but the court held the taxpayer could rely upon an accountant without substantial ties to the seller of the shelter.
Taxpayer Nailed. Kerman v. Comm'r,
2013 U.S. App. LEXIS 7032 (6th Cir. April 8, 2013). In this opinion
the court upheld a 40% penalty, on top of a tax deficiency. It was
unreasonable for the taxpayer to rely upon the opinion of Brown &
Wood, a large New York City law firm, in a "CARD" tax shelter
Tax Avoidance, But not a Tax Shelter as Such. United States v. McBride,
2012 U.S. Dist. LEXIS 161206 (C.D. Utah Nov. 8, 2012). Suit for civil
penalties against Taxpayer for failure to report foreign bank accounts.
Promoter was an entity selling services to Taxpayers to help them to
avoid federal taxes, in part by utilizing foreign bank accounts. To
avoid a willfulness finding Taxpayer claimed he relied upon opinions of
lawyers employed by Promoter. In making liability findings, in this
opinion, the court held that Taxpayer could not avoid a willfulness
finding by relying upon lawyers with conflicts of interest.
Liability. Written court opinions regarding the liability of lawyers investing in clients are rare. The author is aware of a handful of malpractice settlements where the lawyer’s additional role as investor had an undeniable effect on the decision of the lawyer, his law firm, and his law firm’s carrier to settle. While such settlements are few in number, they have been for substantial amounts. An example of how a lawyer’s investment can affect a tribunal’s attitude is SEC v. National Student Marketing Corp., 457 F. Supp. 682 (D.D.C. 1978). That was an enforcement proceeding brought by the SEC against certain participants in a transaction and several of their lawyers. One of the lawyers stood to profit from the consummation of the transaction in question because he owned stock in his client. The court went out of its way to comment on that, 457 F. Supp., at 711.
Julia D. Gray, Pillsbury Winthrop Accused of Malpractice in Atlanta Trust Fund Case, Fulton County Daily Report, December 19, 2001. Following is a summary of the article. Timothy Cobb is the divorced father of two sons, each of whom is beneficiary of a trust. Crichlow is a partner at Pillsbury, and until November 2000, was trustee of the trusts. Pillsbury represented the trusts. The new trustee is Madelyn Adams, former wife of Cobb and mother of the beneficiaries. She has sued Cobb, Crichlow and Pillsbury Winthrop. It seems that the trust had made loans to Cobb's company, edaflow, totaling $2.4 million. Crichlow is an investor in edaflow. The trusts made additional loans totaling some $400,000 to other companies in which Cobb and Crichlow had interests. Much of the money has been lost. Among other claims, Adams claims Crichlow had violated the prudent investor rule (the trusts had a total value of $6.5 million). She also claims Crichlow and the firm had a conflict of interest and were guilty of malpractice.
Gupta v. Rubin, 2001 U.S. Dist. LEXIS 450 (S.D.N.Y. 2001). This opinion was in connection with the denial of a FRCP 12(b)(6) motion, so the ultimate significance of the case remains to be seen. Nevertheless, it is an illustration of possible malpractice liability resulting from a law firm's doing business with a client. In this case, plaintiff alleges that his law firm did not disclose its business relationship with another party, with whom the plaintiff was doing business.
Robin McDonald, Scam Outfit's Law Firm Sued for Not Checking Fraud Operator, Fulton County Daily Report, August 4, 2000. According to this article defrauded investors have sued Philadelphia's Schnader, Harrison, Segal & Lewis for its having represented an investment partnership that was running a Ponzi scheme. A partner in the law firm had invested $50,000 in the partnership and is believed to have lost $40,000. The principal allegation against that lawyer and the law firm is that they did not check out the background of one of the investment partners. He had been fired from two brokerage firms and had been sued several times. In one case he had a $1.3 million judgment entered against him.
Insurance Coverage. Minnesota Mut. Ins. Co. v. Antonelli, Terry, Stout & Kraus, LLP, 2010 U.S. Dist. LEXIS 122836 (E.D. Va. Nov. 18, 2010); and Minnesota Mut. Ins. Co. v. King, 2010 U.S. Dist. LEXIS 121446 (D. Col. Nov. 1, 2010). In both cases the same lawyer malpractice insurance company ("MM") sued its insured lawyers for a declaration that the matters in question were subject to the policy exclusion that related to lawyers doing non-legal business. In the Virginia case the court entered summary judgment for MM based on the exclusion. In the Colorado case, in addition to relying on the exclusion, MM also claimed that the lawyer/insured had made misrepresentations about his non-legal business in his insurance application. In the cited opinion the court only ruled on procedural issues. However, both cases should serve as a reminder that lawyers doing business with clients need to be mindful of the hazards, including the hazard of losing their insurance coverage. Similar result in Lancia v. State Nat'l Ins. Co., 2012 Conn. App. LEXIS 178 (Conn. App. April 10, 2012).
More on Insurance Coverage. Darwin Nat'l Assurance Co. v. Hellyer, 2011 U.S. Dist. LEXIS 60592 (N.D. Ill. June 7, 2011). Lawyer participated in a land transaction with Lawyer's clients. In this opinion the court held that that participation triggered the business enterprise exclusion in Lawyer's malpractice policy. Abrams, Fensterman, Fensterman, Eisman, Greenberg, Formato & Einiger, LLP v. Underwriters at Lloyd's,
2013 U.S. Dist. LEXIS 1204 (E.D.N.Y. Jan. 2, 2013). Law Firm got mixed
up in the insurance business. When Law Firm got sued for this
activity, its malpractice carrier denied coverage under an exclusion
dealing with lawyers doing business. Law Firm filed this action to
enforce coverage. In this opinion the court granted summary judgment to
the carrier holding that the exclusion applied.
Inducing Clients to Invest. Minnesota Lawyers Mut. Ins. Co. v. Ahrens, 2010 U.S. Dist. LEXIS 107873 (M.D. Pa. Oct. 8, 2010). Law Firm allegedly caused Clients to invest several million dollars in an investment scheme. Clients lost their money and sued Law Firm. Law Firm's malpractice carrier ("InsCo") filed this action seeking a declaration that an exclusion in its policy, relating to investment activities, precludes coverage for the investment losses. In this opinion, construing the exclusion, the court granted InsCo a judgment on the pleadings. [Editorial Comment: we had thought that lawyers stopped inducing their clients to enter into investments years ago, particularly because of jaw-boning by malpractice carriers. Evidently, some lawyers will never learn.]
Can Jeopardize Malpractice Coverage. Continental Cas. Co. v. Fenigstein & Kaufman, 2009 U.S. Dist. LEXIS 48696 (C.D. Cal. May 20, 2009).
More Coverage (No) Cases. Lee & Amtzis, LLP v. Am. Guar. & Liab. Ins. Co., No. 653050/11 13711 (N.Y. App. Div. April 7, 2015); Burk & Reedy, LLP v. Am. Guar. & Liab. Ins. Co., 2015 WL 1286039 (D.D.C. March 23, 2015).
Tex. Op. 626 (April
2013). Lawyer represented Corp. A and thereby learned information about
Corp. A and the relevant industry. Corp. A was purchased, and Lawyer's
representation ended. Later, Lawyer made a "significant" investment in
Corp. B, a competitor of Corp. A. In this opinion the committee held
that the investment violated Texas ethics rules. [Note: when Texas
adopted its version of the ABA Model Rules, it changed things around for
no apparent reason. Thus, this opinion is largely based upon Texas'
version of MR 1.6, which resembles MR 1.9(c). Under any formulation the
opinion points to the correct result. Hats off to the ABA/BNA Lawyers
Manual on Professional Conduct, May 22, 2013 edition of Current Reports
for flagging this opinion and providing an excellent analysis.]
Other Cases on Investing in or with Clients: Neill v. All Pride Fitness of Washougal, LLC, 2009 U.S. Dist. LEXIS 42145 (W.D. Wash. May 4, 2009) (court allowed 17% owner to defend LLC); Avianca, Inc. v. Corriea, 705 F. Supp. 666 (D.D.C.), aff'd, 1995 U.S. App. LEXIS 30863 (D.C. Cir. 1995); Rothman v. Wilson, 121 F.2d 1000 (9th Cir. 1941); Ruth v. Crane, 392 F. Supp. 724 (E.D. Pa. 1975), aff'd, 562 F.2d 90 (3d Cir. 1977); In re Spear, 774 P.2d 1335 (Ariz. 1989); Gold v. Greenwald, 55 Cal. Rptr. 660 (Cal. App. 1966); Melson v. Michlin, 223 A.2d 338 (Del. 1966); Tower Investors, LLC v. 111 East Chestnut Consultants, Inc., 864 N.E.2d 927 (Ill. App. 2007) (partners invested in entity that lent money to clients; client was unsuccessful in using this against firm); Comm. on Prof. Ethics and Conduct of Iowa State Bar Ass'n. v. Humphreys, 524 N.W.2d 396 (Iowa 1994); Comm. on Prof. Ethics and Conduct of Iowa State Bar Ass'n. v. Mershon, 316 N.W.2d 895 (Iowa 1982); Mathews v. Spears, 24 So. 2d 195 (La. App. 1945); Goldman v. Kane, 329 N.E.2d 770 (Mass. App.01975); Rowland v. Monroe, 1996 Minn. App. LEXIS 1195 (Minn. App. 1996); In re Lowther, 611 S.W.2d 1 (Mo. 1981); In re Discipline of Singer, 865 P.2d 315 (Nev. 1993); In re D'Angelo, 733 P.2d 360 (N.M. 1986); In re Reiss, 502 A.2d 560 (N.J. 1986); Greene v. Greene, 436 N.E.2d 496 (N.Y. 1982); In re Harrington, 718 P.2d 725 (Or. 1986); In re O'Byrne, 694 P.2d 955 (Or. 1985); In re McGlothlen, 663 P.2d 1330 (Wash. 1983); Chancery Estate Holdings Corp. v. Sahara Real Est. Invest. Inc., 2011 BCSC 1067 (CanLII) (S. Ct. B.C. Aug. 5, 2011).
Other Ethics Opinions: Col. Op. 109 (2001); D.C. Op. 179 (1987); Kan. Op. 98-06 (9/15/98);.Miss. Op. 230 (1995); Pa. Op. 89-158 (1989); Utah Op. 98-13 (1998); Va. Op. 1593 (1994).
Ill. Op. 13-4 (May
2013). Lawyer owns 8% of Bank and is Chairman of Bank's board. Lawyer
represents Municipality, which does business with Bank. This opinion
explores Lawyer's obligations under Rules 1.8(a) and 1.7(a)(2) (material
limitation). The opinion says that the the relationship is probably
"nonconsentable" under Rule 1.7(a)(2). The opinion is not clear whether
Lawyer can avoid a violation by not representing Municipality in
dealings with Bank, while representing the Municipality on other
Treatises. Hazard, Hodes, & Jarvis §§ 11.17 & 12.2-12.5; Rotunda & Dzienkowski § 1.8-2(a)(1).
Law Reviews. John S. Dzienkowski & Robert J. Peroni, The Decline in Lawyer Independence: Lawyer Equity Investments in Clients, 81 Tex. L. Rev. 405 (Dec. 2002); Jason M. Klein, No Fool for Client: The Finance and Incentives Behind Stock-Based Compensation for Corporate Lawyers, 1999 Colum. Bus. L. Rev. 329; Gwyneth E. McAlpine, Getting a Piece of the Action: Should Lawyers be Allowed to Invest in their Clients' Stock? 47 U.C.L.A. L. Rev. 548 (1999); Richard M. Maltz, Lawyer-Client Business Transactions: Caveat Counselor, 3 Geo. J. Legal Ethics 291 (1989).
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